Integrated Analysis of Ratios
The ratios discussed so far measure a firm’s liquidity, solvency, efficiency of operations and profitability independent of one mother. However, there exists interrelationship among these ratios. This aspect is brought out by integrated analysis of ratios. The dis-aggregation of ratios can reveal certain major economic and financial aspects, which otherwise would have been ignored: For instance, significant changes in profitability measured in terms of return on assets (ROA) and return on equity (ROE) are understood better through an analysis of its components.
The various profitability ratios discussed earlier throw light on the profitability of a firm from the viewpoint of (i) the owners of the firm, and (ii) the operating efficiency of the firm. The ratios covered under the rate of return to the equity-holders fall under the first category. The operating efficiency of a firm in terms of the efficient utilization of the resources is reflected in net profit margin. It has been observed that although a high profit margin is a test of better performance, a low margin does not necessarily imply a lower rate of return on investments if a firm has higher investments/assets turnover. Therefore, the overall operating efficiency of a firm can be assessed on the basis of a combination of the two. The combined profitability is referred to as earning power/return on assets (ROA) ratio. The earning power of a firm mar be defined as the overall profitability of an enterprise. This ratio has two elements: (i) profitability on sales as reflected in the net profit margin, and (ii) profitability of assets which is revealed by the assets/investment turnover. The earning power (ROA ratio) of a firm can be computed by multiplying the net profit margin and the assets turnover. Thus,
Earning power = Net profit margin x Assets turnover
where, Net profit margin = Earning after taxes/Sales
Asset turnover = Sales/Total assets
The ROA ratio is a central measure of the overall profitability and operational efficiency of a firm. It shows the interaction of profitability and activity ratios. It implies that the performance of a firm can be improved either by generating more sales volume per rupee of investment or by increasing the profit margin per rupee of sales.